The FE Alpha Manager (pictured) says investors are blindly buying top-performing funds that no longer have the flexibility to deliver the same level of returns, due to their rapidly increasing size. Even more worrying, according to Coombs, is the impact these inflows are having on valuations within entire asset classes.
"I think it’s incredibly worrying," he said. "People were buying into the track record of funds when they were £500m, but they can’t operate in the same way now because they’re so much bigger."
"You’ve had some funds changing their mandates for this reason. Look at Findlay Park American, which used to be the Findlay Park American Smaller Companies fund."
He points to the strong performance of Jupiter Strategic Bond as an example of a fund that cannot operate in the same way as it did during the peak of its performance.
Performance of fund vs sector since launch
Source: FE Analytics
"The manager [Ariel Bezalel] had a lot of good performance because he was buying oil rig financial bonds. Can he buy these in the same way now? I don’t think so."
"These days it’s not just about how good the manager is – it’s about the product. I sold out of M&G Recovery [due to concerns over size], but if Tom Dobell launched a best-ideas portfolio or an investment trust, I’d snap your hand off," he added.
Coombs says protecting against this risk is simple – just buy a smaller, more nimble fund, with an equally adept manager.
However, he says the mass inflows have a far more serious knock-on effect.
"We’re getting to the point where these massive funds are actually moving prices, which is a big worry – particularly in illiquid markets," he said. "If one of the mega bond funds dumps a load of RBS, the small funds that hold it are going to feel the pain as well."
"There’s no use switching out of the large fund and into a small one – the whole asset class is affected."
"We own M&G Optimal Income on the private client side, but there’s no point in switching out of it. If there’s a 10 per cent outflow from this fund, it’s going to have an impact on prices anyway."
Coombs currently has no corporate bond exposure in his multi-asset funds for this very reason. While he does not think the problem will end up in an all-out crash, he thinks there will be far greater volatility in the bond market.
"I think it’s a bad epidemic, which is affecting the entire industry," he added.
Coombs is the second FE Alpha Manager in the space of three days to highlight the problem of mass inflows going into an elite group of giant funds: Margetts’ Toby Ricketts made a similar point in an interview earlier this week.
Coombs says fund groups such as Troy, JO Hambro and Aberdeen have been far more proactive than most in combating these dangers, through soft-closures.
"You’ve got to hold your hands up and applaud them," he said.
"In the past, funds that limited inflows have been a real pain. We hold an Edgbaston fund, for example, which limits the amount of money you can invest every month. It can be frustrating, but it’s the right thing to do."
"The problem even these groups have, though, is that FSA regulations don’t allow funds to hard-close. If you look at the Trojan fund, it’s more than doubled in size since it soft-closed," he added.
Mike Webb, chief investment officer at Rathbones, agrees with Coombs, but is hopeful that RDR will address some of the issues highlighted by his colleague.
"If you look at the inflows into the Sterling Strategic Bond sector in the two months to February this year, 88 per cent went into a single fund – it’s incredible," he said.
"The problem isn’t now, but when liquidity dries up. Even the smaller funds could suffer when this happens."
"I’d like to think that RDR will address this herd mentality to some extent. The whole idea of RDR is the quality of advice, and hopefully there will be a move to qualitative analysis, and not just quantitative."
According to FE inflows data, M&G Optimal Income has seen inflows of more than £4bn in the last 12 months alone.
The next biggest seller – Jupiter Strategic Bond – has seen inflows of around £650m, while the 10th bestseller has seen just £55m.
It is a similar story across a number of IMA sectors. Standard Life GARS and Newton Real Return have received combined inflows of almost £5bn in the last year, while the third best-selling Absolute Return fund – CF Ruffer Total Return – has seen just £120m.
Commenting on Coombs’ claims, Jupiter Strategic Bond manager Bezalel (pictured) told FE Trustnet that he is perfectly happy with the volume of assets that he runs, and is confident that he has the flexibility to outperform in the future.
"We are pleased to have delivered first or second quartile performance year-in, year-out, regardless of size or how rapidly we have grown," he said. "Oil rig financing has been a contributor to performance, but is one of many themes we have played since the fund launched."
"It has made up roughly between 5 and 10 per cent of the portfolio since we launched and goes a small way to explaining the 70 per cent returns we have achieved since inception."
"What we have demonstrated since the launch of the fund in 2008 is that returns can come from a number of different themes across the ratings spectrum."
"Other big drivers of performance include a correct call on the investment potential of deeply subordinated bank bonds and distressed debt in 2009 and a large position in long-dated Australian government bonds in 2010."
"More recently, pub securitisation has been a theme we have developed and this has produced equity-like returns in the last 12 months."
"We firmly believe that we can continue to deliver outperformance for clients regardless of the growth in assets that we have attracted since the fund’s launch nearly five years ago."
The £1.47bn Jupiter Strategic Bond fund requires a minimum investment of £500 and has a total expense ratio (TER) of 1.51 per cent.